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Pollution, Factor Taxation and Unemployment

University of Helsinki - Department of Political and Economic Studies; CESifo (Center for Economic Studies and Ifo Institute); Bank of Finland - Research Department; Institute for the Study of Labor (IZA)

CESifo (Center for Economic Studies and Ifo Institute); National Bureau of Economic Research (NBER); Ludwig-Maximilians-Universität München

International Tax and Public Finance, Vol. 5, Issue 3, 1998

Abstract:

When consumers choose between clean and dirty goods and the labor market clears, a green tax reform may not bring about a double dividend in the sense of increasing environmental quality and increasing employment. However, when firms choose between clean and dirty factors of production, and when there is unemployment, such a result is very likely to occur. The paper investigates a model of a monopolistic firm where labor and energy are factors of production and trade unions negotiate the wage rate, accepting some unemployment as a result of aggressive wage demands. It is shown that, in such a framework, a green tax reform will boost employment provided it does not increase the net-of-tax wage rate by too much. This is the case when the elasticity of substitution between labor and energy is greater than one, equal to one or not too far below one.